View: Why RBI's lament may lead to more stress in the economy

Good central banks everywhere recognise and accept this, and do not try to push the envelope to a point where it could boomerang on all concerned.

US President Donald Trump ‘maybe regrets’ appointing Jerome Powell as chairman of the US Federal Reserve. He was responding to questions about the growing tension between the US central bank and government over the Fed’s interest rate policy. Substitute Prime Minister Narendra Modi for Trump, Urjit Patel for Powell, and Reserve Bank of India (RBI) for the US Fed, and there, you have it. After Friday’s speech by RBI deputy governor Viral Acharya, GoI must be ruing the day it appointed Patel as RBI governor.

Tension between elected governments and non-elected central banks is not new. In the US, Trump has been vocal, and Powell, despite considerable provocation, restrained. In India, it is the other way round. GoI, though increasingly (and with some justification) unhappy with RBI, has not voiced its displeasure publicly. But that has not held RBI back.

Another Bad ChoiceThe speech may have been delivered by deputy governor Acharya. But it is unimaginable he would have said what he did without governor Patel’s approval. Reading between the lines, it’s almost as if Patel is shooting from the shoulder of his less than two years into the job deputy.

Had Acharya made a reasoned case for central bank independence, or defended RBI’s somewhat patchy record of late, posterity may judge him kindly. The case for operational — as distinct from blanket — autonomy has never been in dispute. But by launching a thinly veiled attack on GoI and holding out the threat of market mayhem with scant regard to the timing and context, Acharya has done a distinct disservice, not only to RBI, but also to the country.

To add insult to injury, he has compared India with Argentina, a country that has defaulted seven times on its international debt and five times on its domestic debt since its independence from Spain in 1818. Contrast that with India’s spotless record.

At a time when growing geopolitical tensions and looming US oil sanctions on Iran are threatening our already fragile external sector and macroeconomic and financial stability, it is hard to understand why Acharya chose to be the trigger for the very consequences he was warning against. It would be no surprise if foreign investors respond by exiting when markets open today.

But let me get to specifics, the three main points of contention raised by Acharya, two of which are highly technical: RBI’s limited control over public sector banks (PSBs), need to protect its balance-sheet, and the proposal to set up a separate payments regulator.

On PSBs, there is enough historical evidence that RBI does not suffer from lack of power. On the contrary, it enjoys much more clout with PSBs, having a representative on the board of each one, and shotgun marriages to bail out troubled banks have invariably been forced on public, rather than private, banks. The truth is RBI representatives have little to show for their presence, private sector banks are not much better off than their public sector counterparts, and RBI singularly failed to stop the rot in non-banking finance companies (NBFCs).

The plea of insufficient powers vis-à-vis PSBs must be seen for what it is: an attempt to deflect criticism of sleeping on the watch.

On RBI’s balance-sheet, the picture is more complex. While it is, no doubt, important for RBI to have a strong balance-sheet, a substantial part of the central bank’s revenue comes from seigniorage — the difference between the face value and the cost of printing currency.

RBI, Take NotesIt arises directly from its note-issuing authority, and in many countries, this is transferred wholly to government. So, even as there is a case for building reserves, there is also an equally valid case for framing clear rules to fix how much should be transferred to government and how much should go to build reserves.

Does RBI, for instance, need such a large contingency reserve? Could it learn, instead, from the very same US Fed that came in for Acharya’s praise? After the Lehman Brothers crisis, the US Fed’s action — ‘quantitative easing’ — was nothing but deficit financing. Even if it doesn’t go that far, can RBI take a more nuanced, less confrontational approach, on reserves?

On the move to set up a separate payments regulator, this is only a draft proposal now. Yes, governance of payment and settlement systems is part of the core responsibility of most central banks. But there are other models, notably in the US and Canada. In any case, the subject is so abstruse, that it does not lend itself to public debate and could have been resolved through discussions with the finance ministry.

If only Acharya had paid heed to former RBI governor Y V Reddy. “There is no such thing as blanket independence. RBI is independent; within the limits set by government,” Reddy had said. That is how it should be. True, there is a tendency for governments everywhere to frame policy with an eye on the next elections, while central banks have a longer time-frame. But differences arising out of this time-inconsistency problem are best resolved amicably in closed-door meetings, not through virtual rabble-rousing.

In a democracy, governments, not unelected central banks, are answerable to the people. Good central banks everywhere recognise and accept this, and do not try to push the envelope to a point where it could boomerang on all concerned.

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)